Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes and the other information included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties and are not guarantees of future performance. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly those under “Risk Factors.” Dollars in tabular format are presented in thousands, except per share data, or otherwise indicated.
OVERVIEW
GrowGeneration Corp. (together with all of its direct and indirect wholly owned subsidiaries, collectively “GrowGeneration” or the “Company”), incorporated in Colorado in 2014, is the largest chain of specialty retail hydroponic and organic garden centers in the U.S. and is a leading marketer and distributor of products for both indoor and outdoor hydroponic and organic gardening. The Company also engages in the distribution of private label products and commercial benching. Currently, GrowGeneration has 60 retail locations across 16 states in the U.S. We also operate an online superstore for cultivators at growgeneration.com, as well as a wholesale business for resellers, HRG Distribution. Our business is driven by a wide selection of products, facility design services, solutions driven staff and pick, pack and ship distribution and fulfillment capabilities. GrowGeneration carries and sells thousands of products, including nutrients, growing media, lighting, environmental control systems, vertical benching and accessories for hydroponic gardening, as well as other indoor and outdoor growing products, that can be used for growing a wide range of plants. Our products include proprietary brands such as Charcoir, Drip Hydro, Power Si, MMI benching and racking, and more. GrowGeneration also provides facility design services to commercial growers. We employ approximately 455 employees, a majority of them we have branded as “Grow Pros”. Currently, our operations span over 946,000 square feet of retail and warehouse space.
MARKETS AND BUSINESS SEGMENTS
Our target customer segments include commercial and craft growers in the plant-based medicine market, as well as vertical and urban farmers who grow organic herbs, fruits and vegetables. Unlike the traditional agricultural industry, these cultivators use innovative indoor and outdoor growing techniques to produce specialty crops in highly controlled environments. This enables them to produce crops at higher yields and quality, regardless of the season or weather conditions. Our commercial benching business customers also include retailers and other businesses.
The Company has three primary reportable segments, including retail operations, e-commerce, and distribution and other. The Company has segmented its operations to reflect the manner in which management reviews and evaluates the results of
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its operations. The structure reflects the manner in which the chief operating decision maker regularly assesses information for decision-making purposes, including the allocation of resources.
We operate our business through the following business segments:
• Retail : The core of our business strategy is to operate the largest chain of retail garden centers in the U.S. The hydroponic retail landscape is fragmented, which allows us to acquire “best of breed” hydroponic retail operations and leverage efficiencies of a centralized organization. During 2022, the Company acquired or opened 5 new locations and expanded its physical retail presence into 4 new states. Our plan is to continue to acquire, open and operate garden centers and related businesses throughout the U.S. However, in light of persistent difficult market conditions, the Company also closed 8 underperforming retail locations in 2022 and may consider additional store consolidation in 2023. Some of our garden centers have multi-functions, with added capabilities that include warehousing, distribution and fulfillment for our online platforms and direct fulfillment to our commercial customers.
Our retail segment also includes our commercial sales organization, which is focused on selling products and services, including end-to-end solutions, for large commercial cultivators outside of the physical retail network. When a commercial customers gain new cultivation licenses, they need lighting, benching, environmental control systems, irrigation, fertigation and other products to outfit their facilities. Existing facilities also need consumable products for operations, as well as equipment updates from time to time. Commercial customers typically purchase large dollar amounts and sizes of products. We offer commercial customers volume pricing, terms and financing.
• E-Commerce : Our digital strategy is primarily focused on capturing the home, craft and commercial grower online. GrowGeneration.com offers thousands of hydroponic products, all curated by our product team. GrowGeneration.com offers customers the option to have their orders shipped directly to their locations, anywhere in North America. GrowGeneration also sells its products through its distribution website, HRGdist.com, and online marketplaces such as Amazon and Walmart.
• Distribution and other: In December 2020, GrowGeneration purchased the business of Canopy Crop Management Corp., the developer of the popular PowerSi line of monosilicic acid products, a widely used nutrient additive for plants. In March 2021, the Company purchased Charcoir, a line of premium coco pots, cubes and medium. In December 2021, the Company purchased the assets of Mobile Media, Inc. ("MMI"), a mobile shelving and storage solutions developer and manufacturer. In February 2022, the Company purchased the assets of Horticultural Rep Group, Inc. ("HRG"), a specialty marketing and sales organization of horticultural products. The Company is in the process of combining the operations and management of these non-retail enterprises. The products these companies provide are integrated into our retail, e-commerce, and direct sales activities and we receive incremental revenue from the sale of these products.
We recognize specifically identifiable operating costs such as cost of sales, distribution expenses, selling and general administrative expenses within each segment. Certain general and administrative expenses, such as administrative and management expenses, salaries and benefits, share based compensation, director fees, legal expenses, accounting and consulting expenses and technology costs, are not allocated to the specific segments and are reflected in the enterprise results.
GROWTH STRATEGIES
Core to our growth strategy is to expand the number of our retail garden centers in the U.S., especially in markets where we do not already have a physical presence, or where our existing physical presence is limited. During 2022, the Company acquired or opened 5 new locations and expanded its physical retail presence into 4 new states. Our plan is to continue to acquire, open and operate garden centers. However, in light of difficult market conditions that persisted throughout the year, the Company also closed 8 underperforming retail locations in 2022 and may consider additional store consolidation in 2023.
GrowGeneration will also pursue growth through expansion of its commercial sales and distribution capabilities to sell more product to commercial cultivators for large grow operations and independent retail garden centers for resale, as well as by promoting and expanding its portfolio of proprietary brands to increase its market share, product offerings and profitability.
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RESULTS OF OPERATIONS
Sales
Net sales for the year ended December 31, 2022 were approximately $278.2 million, a decrease of 34.2% over the year ended December 31, 2021, which was approximately $422.5 million. 2021 net revenue increased approximately 118.5% over the year ended December 31, 2020, which was approximately $193.4 million.
The decrease in net revenues for the year ended December 31, 2022 compared to the year ended December 31, 2021 is due to a decrease of approximately $178.0 million in same store sales, which represented a 51.6% decrease year-over-year, which is primarily attributable to the downturn in the business cycle for cannabis cultivators, resulting in less supply and equipment purchasing. Overall sales in our retail segment declined from $369.2 million to $205.5 million and overall sales in our e-commerce segment declined from $36.2 million to $15.1 million year over year. These declines were partially offset by an increase in sales from our distribution and other segment from $17.1 million for the year ended December 31, 2021 compared to $57.6 million for the year ended December 31, 2022 due to the acquisitions of HRG and MMI.
The increase in 2021 revenues over 2020 is due to an increase in same store sales of approximately $40.1 million, which represented 24.4% growth year-over-year. Distributed sales in 2021 were $17.1 million from acquisitions of Power Si and Charcoir. E-commerce sales increased from $10.6 million in 2020 to $36.2 million in 2021 primarily attributable to $11.2 million growth in owned e-commerce sites and $14.4 million from the Agron acquisition.
Cost of Sales
Cost of sales for the year ended December 31, 2022 decreased approximately $96.3 million or 31.7% compared to the year ended December 31, 2021. The decrease in cost of sales is primarily due to the 34.2% decrease in sales.
Cost of sales for the year ended December 31, 2021 increased approximately $161.9 million or 113.8% compared to the year ended December 31, 2020. The increase in cost of sales was directly attributable to the 118.5% increase in revenues, as detailed above, comparing the year ended December 31, 2021 to 2020.
Gross profit was approximately $70.3 million for the year ended December 31, 2022, compared to approximately $118.2 million for the December 31, 2021, a decrease of approximately $48.0 million or 40.6%. The decrease in gross profit is primarily related to the 34.2% decrease in revenues. Gross profit as a percentage of revenues was 25.3% for the year ended December 31, 2022, compared to 28.0% for 2021. The decrease in the gross profit margin percentage is primarily due to increased freight costs as well as higher levels of product discounting in the retail segment.
Gross profit for the year ended December 31, 2021 increased approximately $67.2 million or 131.6% compared to the year ended December 31, 2020. Gross profit as a percentage of sales was 28.0% for the year ended December 31, 2021, compared to 26.4% for the year ended December 31, 2020.
Operating Expenses
Operating expenses are comprised of store operations, selling, general, and administrative, and depreciation and amortization. Operating costs were approximately $238.1 million for the year ended December 31, 2022 and approximately $103.2 million for the year ended December 31, 2021, an increase of approximately $134.9 million or 130.7%. The increase in operating expenses is primarily attributable to the impairment loss of $127.8 million recorded during 2022, which was primarily attributable to the decline in the Company's market capitalization below net assets in addition to the Company's declining performance.
Operating expenses for the year ended December 31, 2021 increased approximately $60.6 million or 142.3% compared to the year ended December 31, 2020.
Store operating costs, primarily payroll, rent and utilities, and allocated corporate overhead costs, were approximately $54.7 million for the year ended December 31, 2022, compared to $49.7 million for the year ended December 31, 2021, an increase of $4.9 million or 9.9%. The increase in store operating costs was directly attributable to the addition of 23 locations that were added during 2021.
During 2021, store operating costs increased approximately $31.0 million or 165.7% compared to the year ended December 31, 2020. The increase in store operating costs was directly attributable to the 118.5% increase in revenues and the addition of 23 locations that were added during 2021. Pre-opening expenses for new stores opened during the period increased approximately $0.9 million during 2021.
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Total corporate overhead, which is comprised of Selling, general, and administrative expense and Depreciation and amortization expense, was approximately $55.6 million for the year ended December 31, 2022, compared to $53.5 million for the year ended December 31, 2021, an increase of $2.1 million or 4.0%. Selling, general, and administrative costs were approximately $36.8 million for the year ended December 31, 2022, compared to approximately $39.5 million for the year ended December 31, 2021. Salaries expense decreased to $18.4 million for the year ended December 31, 2022 from $20.0 million for the year ended December 31, 2021. General and administrative expenses increased to $14.5 million from $14.3 million.
During 2021, total corporate overhead was approximately $53.5 million for the year ended December 31, 2021, compared to $23.9 million for the year ended December 31, 2020, an increase of $29.6 million or 124.0%. Selling, general, and administrative costs were approximately $40.9 million for the year ended December 31, 2021, compared to approximately $21.5 million for the year ended December 31, 2020. Salaries expense increased to $20.0 million from $8.6 million primarily due to an increase in corporate staff and general and administrative expenses increased to $14.3 million from $5.0 million to support expanding operations. These increases were partially offset by a decrease in share-based compensation to $6.6 million from $7.9 million primarily due to new executive compensation agreements effective January 1, 2020 that had front loaded vesting provisions for shares and options that were granted January 1, 2020 for which the remaining vesting was over a two-year period.
Impairment loss was approximately $127.8 million for the year ended December 31, 2022 following impairment testing of goodwill and intangible assets performed in the second quarter as a result of the Company’s market capitalization falling below total net assets. In addition, financial performance continued to weaken during the quarter for which testing was performed. Refer to Critical Accounting Policies, Judgments, and Estimates and Note 6, Goodwill and Intangible Assets , of the notes to the consolidated financial statements for additional information.
Net Income (Loss)
Net loss for the year ended December 31, 2022 was approximately $163.7 million, compared to net income of approximately $12.8 million for the year ended December 31, 2021, a decrease of approximately $176.5 million.
Net income for the year ended December 31, 2021 was approximately $12.8 million, compared to net income of approximately $5.3 million for the year ended December 31, 2020, an increase of $7.5 million. Net income for 2021 compared to 2020 was primarily impacted by a 118.5% increase in revenues, offset slightly by increased cost of goods sold of 113.8%. Store operating costs as a percentage of revenue was 11.8% in 2021, compared to 9.7% offsetting the increase in cost of sales.
CONDENSED 2022, 2021, AND 2020 RESULTS OF OPERATIONS (in thousands)
For the Year Ended
December 31,
2022 2021 2020
Sales, net $ 278,166 $ 422,489 $ 193,365
Cost of Sales 207,903 304,248 142,317
Gross profit 70,263 118,241 51,048
Operating expenses 238,138 103,239 42,611
Income (loss) from operations (167,875) 15,002 8,437
Other income (expense) 1,243 227 142
Pre-tax net income (loss) (166,632) 15,229 8,579
Income taxes 2,885 (2,443) (3,251)
Net income (loss) $ (163,747) $ 12,786 $ 5,328
Use of Non-GA AP Financial Information
The Company believes that the presentation of results excluding certain items in “Adjusted EBITDA,” such as non-cash equity compensation charges, provides meaningful supplemental information to both management and investors, facilitating the evaluation of performance across reporting periods. The Company uses these non-GAAP measures for internal planning and reporting purposes. These non-GAAP measures are not in accordance with, or an alternative for,
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generally accepted accounting principles and may be different from non-GAAP measures used by other companies. The presentation of this additional information is not meant to be considered in isolation or as a substitute for net income or net income per share prepared in accordance with generally accepted accounting principles.
Set forth below is a reconciliation of Adjusted EBITDA to net income (loss) (in thousands except per share data):
Year ended December 31,
2022 2021 2020
Net income (loss) $ (163,747) $ 12,786 $ 5,328
Income taxes (2,885) 2,443 3,251
Interest income (580) (486) (44)
Interest expense 21 43 14
Depreciation and Amortization 17,132 12,600 2,436
EBITDA $ (150,059) $ 27,386 $ 10,985
Impairment loss 127,831 — —
Share based compensation (option compensation, warrant compensation, stock issued for services)
4,967 6,585 7,856
Fixed asset disposal 568 197 —
Adjusted EBITDA $ (16,693) $ 34,168 $ 18,841
Adjusted EBITDA per share, basic $ (0.27) $ 0.58 $ 0.43
Adjusted EBITDA per share, diluted $ (0.27) $ 0.57 $ 0.41
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2022, we had working capital of approximately $134.9 million, compared to working capital of approximately $169.8 million as of December 31, 2021, a decrease of approximately $34.9 million. The decrease in working capital from December 31, 2021 to December 31, 2022 was due primarily to a decrease in inventory and prepaid inventory partially offset by a decrease in current liabilities. As of December 31, 2022, we had cash and cash equivalents of $40.1 million. Currently, we have no extraordinary demands, commitments or uncertainties that would reduce our current working capital. Our core strategy continues to focus on expanding our geographic reach across the United States and building our store and brand portfolio through organic growth and acquisitions. We believe that some of our acquisitions and new store openings can come from cash flow from operations.
As of December 31, 2021, we had working capital of approximately $169.8 million, compared to working capital of approximately $229.0 million as of December 31, 2020, a decrease of approximately $53.1 million. The decrease in working capital from December 31, 2020 to December 31, 2021 was due primarily to business acquisitions completed during the year ended December 31, 2021 for which the cash consideration was approximately $80.8 million. This decrease in working capital related to business acquisitions was partially offset by an increase in inventory associated with more locations and our ability to leverage greater bulk purchasing due to our growth. At December 31, 2021, we had cash and cash equivalents of approximately $41.4 million and available for sale debt securities of $39.8 million.
We currently do not anticipate any immediate need for additional financing. Management believes that the Company is currently adequately funded to support current and and future operations. We will evaluate the need for additional financing in the future to continue to grow our business, including through acquisitions. To date we have financed our operations through the sale of newly issued common stock, warrants and convertible debentures as discussed below.
Operating Activities
Net cash provided by operating activities for year ended December 31, 2022 was approximately $11.9 million, compared to $5.2 million for the year ended December 31, 2021. The Company reduced prepaid inventory by $10.3 million in the
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current year as well as inventory by $32.9 million, partially offset by payments for accounts payable, accrued payroll, and a reduction in customer deposits.
Net cash provided by operating activities for year ended December 31, 2021 was approximately $5.2 million, compared to net cash used of $213 thousand for the year ended December 31, 2020. Cash used in operations as a result of an inventory increase was primarily attributable to our additional store count. In addition, we used our capital capabilities to secure production of product overseas through prepaid inventory purchase commitments with long lead times in advance of spring 2022 needs. Cash used in accounts and notes receivable decreases were primarily driven by increased revenues partially offset by the collection of notes receivable. Cash provided by the increase in accounts payable and accrued liabilities and customer deposits are attributable to our increased store count and related increase in cost of sales. The increase in payroll liability is primarily driven by increased headcount related to our increased operations.
Investing Activities
Net cash provided by investing activities was approximately $11.6 million for the year ended December 31, 2022 compared to cash used of approximately $139.3 million for the year ended December 31, 2021. Investing activities in 2022 were primarily attributable to acquisitions of $7.2 million, purchase of marketable securities of $38.7 million, and purchase of vehicles and store equipment of $12.9 million, partially offset by $46.6 million of marketable security maturities. Investing activities for the year ended December 31, 2021 were primarily related to store acquisitions of $80.8 million and the purchase of vehicles and store equipment of $18.7 million.
Net cash used in investing activities was approximately $139.3 million for the year ended December 31, 2021 and approximately $45.8 million for the year ended December 31, 2020. Investing activities in 2021 were primarily attributable to acquisitions of $80.8 million, purchase of marketable securities of $75.0 million, and purchase of vehicles and store equipment of $18.7 million, partially offset by $35.2 million of marketable security maturities. Investing activities for the year ended December 31, 2020 were primarily related to store acquisitions of $41.4 million and the purchase of vehicles and store equipment of $3.4 million.
Financing Activities
Net cash used in financing activities for the year ended December 31, 2022 was approximately $1.7 million and was primarily attributable to stock withheld to cover payroll taxes. Net cash provided by financing activities for the year ended December 31, 2021 was $2.4 million and was primarily attributable to stock redemptions partially offset by the proceeds from the sale of common stock and exercise of warrants and options. Net cash provided by financing activities for the year ended December 31, 2020 was $211.0 million and was primarily from proceeds from the sale of common stock and exercise of warrants and options.
2020 Offerings
On December 11, 2020, the Company consummated an underwritten public offering of 5,750,000 shares of its common stock, which included the exercise in full of the underwriters’ option to purchase an additional 750,000 shares of common stock to cover over-allotments. The shares were sold at a public offering price of $30 per share, generating gross proceeds of $172.5 million, before deducting the underwriting discounts and commissions and other offering expenses. Net proceeds from the sales of common stock, net of all offering costs and expenses, was approximately $162.5 million.
On July 2, 2020, the Company consummated an underwritten public offering of 8,625,000 shares of its common stock, which included the exercise in full of the underwriters’ option to purchase an additional 1,125,000 shares of common stock to cover over-allotments. The shares were sold at a public offering price of $5.60 per share, generating gross proceeds of $48.3 million, before deducting the underwriting discounts and commissions and other offering expenses. Net proceeds from the sales of common stock, net of all offering costs and expenses, was approximately $44.6 million.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, and expense and related disclosures. On an ongoing basis, management bases and evaluates estimates on historical experience and on various other market-specific and other relevant assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from those estimates.
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We believe the following critical policies reflect the more significant judgments and estimates used in preparation of the consolidated financial statements.
Impairment of Goodwill and Intangible Assets
Goodwill reflects the cost of an acquisition in excess of the fair values assigned to identifiable net assets acquired. The Company assesses goodwill for impairment during the fourth fiscal quarter or more frequently if events or changes in circumstances indicate the asset might be impaired. The Company performs impairment assessment for its reporting units using a fair value method based on management's judgements and assumptions or third-party valuations. During the second quarter of 2022, the Company concluded it had a triggering event.
For goodwill impairment testing purposes, the Company determined four reporting units, three of which were subject to a quantitative assessment. The fair value of a reporting unit refers to the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date. In estimating the fair value, the Company uses the income approach in which discounted cash flow analyses are used to derive estimates of fair value of each reporting unit. Multiples of earnings based on the average of historical, published multiples of earnings of comparable entities with similar operations and economic characteristics are also used in developing estimated fair values. The inputs utilized in the analyses are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, Fair Value Measurement . These calculations contain uncertainties as they require management to make assumptions about market comparables, future cash flows and appropriate discount rates (based on weighted average cost of capital ranging from 13% to 16% at June 30, 2022) to reflect the risk inherent in the future cash flows and to derive a reasonable enterprise value and related premium. The estimated future cash flows reflect management's latest assumptions of the financial projections based on current and anticipated competitive landscape, including estimates of revenue based on production volumes over the foreseeable future and long-term growth rates, and operating margins based on historical trends and future cost containment activities. A change in any of these estimates and assumptions could produce a different fair value, which could have a material impact on the results of the goodwill impairment test and on the Company's results of operations. The estimated fair value is then compared with the carrying amount of the reporting unit, including recorded goodwill. The Company is subject to financial statement risk to the extent that the carrying amount exceeds the estimated fair value. As a result of the tests, the Company recorded an impairment to goodwill during the second quarter of 2022. Refer to Note 6, Goodwill and Intangible Assets , of the notes to the consolidated financial statements for additional information.
The Company assesses intangible assets with definite lives for impairment whenever events or changes in circumstances indicate that the asset's carrying amount may not be recoverable. In performing our assessment for recoverability of amortizable intangible assets, the Company estimates the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows from intangible assets is less than the carrying amount of the asset, an impairment loss is recognized. A considerable amount of management judgement and assumptions are required in performing the impairment tests. During the second quarter of 2022, the Company concluded it had a triggering event. The Company’s market capitalization fell below total net assets. In addition, financial performance continued to weaken during the quarter, which is contrary to prior experience. Management reassessed business performance expectations, following persistent adverse developments in equity markets, deterioration in the environment in which the Company operates, inflation, lower than expected sales, and an increase in operating expenses. These indicators, in the aggregate, required impairment testing for finite-lived intangible assets at the asset group level and goodwill at the reporting unit level. These impairments were measured under an income approach utilizing forecasted discounted cash flows to determine fair values of the impaired assets. These methods are consistent with the methods the Company employed in prior periods to value intangible assets. The inputs utilized in the analyses are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, Fair Value Measurement , and primarily consist of expected future operating margins and cash flows, weighted average cost of capital rates, estimated salable values and third-party appraisal techniques such as market comparables. To the extent that profitability declines as compared to forecasted profitability or if adverse changes occur to key assumptions or other fair value measurement inputs, further impairment of long-lived assets could occur in the future. Refer to Note 6, Goodwill and Intangible Assets , of the notes to the consolidated financial statements for additional information.
Other Significant Accounting Policies
Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed above, are also critical to understanding the consolidated financial statements. The notes to consolidated financial statements included in this Annual Report on Form 10-K contain additional information related to our accounting policies, including recent accounting pronouncements, and should be read in conjunction with this discussion.
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OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.